An interview with Ray Leonard

Ray Leonard was selected last week to serve as CEO of Hyperdynamics Corp., a Houston-based and AMEX-listed oil and gas company with exploration assets in West Africa. Previously, Ray’s 31-year work in the oil industry has included stints as an executive with Kuwait Energy, Yukos (Russia), and long tenure with Amoco Corp. Ray will be speaking at the ASPO-USA conference on October 13th in Denver (Colorado) and will be joining the ASPO-USA board. A number of international organizations and elite audiences in Washington D.C. have heard his talks and have taken them seriously. Steve Andrews reached him last week and popped several quick questions.

ASPO-USA Question: How would you describe some of the confusion about peak oil, especially in views held by opponents of the peak oil issue?

Leonard: The obvious misunderstanding with peak oil is that the skeptics take a look at the reserves of the world and say—okay, this is how much we’re using this year, and this is how much we have, so we’ll just divide it by that number for years of reserves. In doing that they completely miss the point that peak oil is about being unable to increase the amount of production when demand continues to increase. Peak oil is not about running out of oil.

The proponents who are looking at the fact that peak oil is happening are looking at the actual production figures. And when you look at actual production figures, it is pretty clear that [peak production] is what is happening. From that standpoint, the proponents are right. I don’t think they’re as correct in terms of the size of the reserves in places like Russia and the Arabian Gulf. But the problem is that those very substantial reserves are not under free-market conditions. If international majors such as Exxon-Mobil were developing those resources with their know-how under an open system, they could continue to grow production somewhat. But it’s not an open system and never will be, so the skeptics are just missing reality.

What I characterize as the “Rest of World”—outside OPEC and the former Soviet Union—has peaked and its production is dropping. The proponents are right about the fact that the world is not going to be growing oil production, but the constraint here is not just about geology. It’s also about politics and the way the world operates.

Question: You worked in Kuwait. What do you see as the future of OPEC production?

Leonard: If you go country by country and look at production histories in post-peak countries, the first step to notice is where the production starts to flatten out. The next step is to look at domestic demand, and that usually keeps rising. The OPEC countries have a tendency to subsidize internal markets; that leads to rapidly rising internal consumption. Venezuela and Iran are good examples. Indonesia shows the next step, flat production with rising domestic demand that leads to steadily narrowing exports; now, with their exports gone, Indonesia is no longer a member of OPEC. One by one, the other members of OPEC will fall into that same category. Venezuela and Iran are two countries with a future like Indonesia’s. Eventually, OPEC is going to consist of Saudi Arabia, Kuwait and the Emirates; they’ll be the last three.

As production in the Rest of World drops, OPEC is going to have sway for a certain amount of time; it will be the Golden Age of OPEC. As demand recovers sometime over the next five years, OPEC will have everyone else at a choke point, and that will last for a while.

Question: How fast could OPEC be reduced to the big three of Saudi Arabia, Kuwait and the Emirates?

Leonard: Obviously, what happens in terms of demand recovery will play a big role. We’re in a demand lull, coupled with large excess capacity today, starting with 5 to 6 million barrels a day. It will be a few years before that narrows. Within two to three years, that may get cut in half and you’ll see some price pressure. But from there, you have to take the OPEC countries individually. Iran and Venezuela are getting little or no Western investment; if their policies change, their production curves could change because it is not so much a shortage of reserves as the way they’re developing their reserves. But will their policies change?

Question: What about Russia? You worked there too. What about the challenges to maintaining and/or growing current in Russia?

Leonard: For a number of reasons, I personally think that Russia will struggle to hold on to production of 10 million barrels a day. First, their big fields in both West Siberia and the Urals are mature, high maintenance, and need a lot of intensive work. At the same time, their tax system is so tough that they don’t allow the sorts of financial returns that allow companies to go in and do the detailed work that will increase recovery factors and production in those older fields. Second, they have new areas to open, but again the fiscal terms are such that they don’t really encourage fast development. Third, I personally don’t think that Russia wants to produce more than 10 million barrels a day. They would rather produce 10 mb/day with a higher price than produce as fast as they can with a lower price. So I think they’re smart enough to sit there and adjust their system to produce no more than 10 mb/day.

A lot of people speculate that, “well, as the economy grows, won’t the demand for oil really increase?” Not really. For one thing, Russians subsidize natural gas more than they subsidize oil, and Russia mostly runs on gas. Oil consumption is less than 4 mb/day and it’s not noticeably rising. So they will continue to export around 6 million barrels a day. It’s a managed system, and that’s really the difference between Russia now and Russia at the beginning of this decade.

Question: What about the unconventional oil plays?

Leonard: Unconventional oil is something that will continue to be there; the question is the magnitude of daily production. In Venezuela, there is a problem with regard to investment policies, the role of government, and eventually a greenhouse gas policy problem. In Canada, of course, there is a major question with greenhouse gases, and there is also a price question. I do think that in a few years, when demand bumps up again and bumps into supply, there will be pressure to increase production from unconventional oil, particularly from Canada’s oil sands, but it will face a lot of greenhouse gas pressure by then. So you still will have unconventional oil production, but it will be closer to 3 mb/day rather than the 6 mb/day that the more optimistic people are predicting.

Question: What are the implications of this for the U.S. economy over the next two to three years?

Leonard: The next two-to-three years that I mentioned earlier assumes the scenario in which demand growth starts to recover. If this recession continues, the excess supply scenario could stretch out to four to five years. My personal feeling is that in the developing world, things are going to recover faster so they will drive the recovery.

If there is another oil spike in the US within three years, we’ll have three problems. On the economics side, a price spike will flatten any emerging recovery; the three biggest recessions in the last few decades have all come after oil price rises. I’m not sure how many more times that has to happen before people are convinced as to how close the correlation is between steep oil prices rises and recessions. Granted there were other big factors this time besides the oil price rise, but it played a part. Another oil price spike will break an emerging recovery.

Second, from a national security standpoint, the petro-states such as Russia, Iran and Venezuela will be empowered. For the US, importing 13 million barrels a day is a strategic weakness; it adds up to a billion dollars a day that flows out of the country, and that helps create price spikes. Every time there is a price spike, OPEC has had a higher proportion of remaining world oil reserves and is in a stronger position.

The final point is greenhouse gases. The lower prices this year and for the next two or three ends up slowing the impetus to develop alternative energy sources. The danger is that if an economic or natural security crisis hits because of a shortage of oil, the alternative of preference may be coal, which is the worst of the hydrocarbon fuels from a greenhouse gas perspective.

When you take these three problems, in an odd sort of way I find some encouragement there because in order for the US to take the steps to wean itself off imported oil you really need to take some pretty drastic action. To do that, you need a broad coalition of support. Any one of these three issues by themselves would not garner enough support. But if you package the three issues together, perhaps you will have enough support to do the sorts of things that are necessary.

Question: Any last remark or point?

Leonard: I have mentioned that there does need to be a move away from a dependence on oil, and obviously away from coal. The U.S. has made tremendous progress in increasing natural gas reserves, mostly by focusing on the unconventional side. The advantage to the US is that natural gas is a good medium-term stopgap that is relatively abundant on its own shores. It could be a good core to a strategy for moving past hydrocarbon fuels, but only as a bridge, not as an end in itself. The renewable energy technologies are good and they are there already, but it is going to take much longer than some of the predictions they are making to ramp those resources up, so we’ll need a bridge.

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